Last night, Darcy Henton filed a story which detailed a memorandum of understanding between the Alberta government and TransCanada with respect to the proposed Energy East Pipeline from Alberta to Eastern Canada.

“The province has signed a memorandum of understanding to take up to 100,000 barrels-a-day of firm capacity on TransCanada Corp.’s proposed Energy East pipeline.” –Financial Post, July 4, 2013

I think there are three things people need to consider when evaluating this decision. First, this is not an equity stake in the pipeline or a financial contribution, but a promise to pay for shipping on the pipeline if it is built. Second, Alberta’s move will not in and of itself enable this project. Third, the government of Alberta takes bitumen (and conventional oil and gas) royalties in kind, and their responsibility is to market those products to maximize the value to Albertans. In that sense, what matters is what happens to the oil once it gets east.

What has the government signed? They’ve signed a memorandum of understanding to take up to 100,000 barrels per day of firm capacity on the line if it’s built. What this likely implies, having not seen the MOU, is an option on a take-or-pay contract for shipping services. Under such an arrangement, the government would commit to paying the shipping tolls for up to 100,000 barrels per day regardless of whether or not they actually moved that much product – it’s a subscription service. The government is not taking an equity stake in the pipeline, and will not have to pay anything if the pipeline is not built. Alberta is a player in this market, and there is no escaping it. The Alberta government expects to receive over 200,000 barrels per day of royalty bitumen (PDF) by the time Energy East is in service. They have a couple of choices with respect to shipping – they can sign firm shipping agreements, or hope there is capacity available if they wait for spot shipping at time of receipt. The government has chosen a lower-risk option, but Albertans should ask whether this is the best low-risk option for the government among the many pipeline proposals currently looking to move oil to tidewater from the mid-continent.

There is some risk to the province, which Richard Masson outlines well in the Henton article. First, Energy East may end up being an expensive option. If the tolls are higher on Energy East than on other systems serving similarly priced markets, the netback to Albertans will be lower for shipping on that line. The province is also subject to market risk, in that prices on the Atlantic coast may not be higher than other pricing points by the time this line is built. I also argue below that they may have increased political risk by going east.

The approval process for a project like Energy East requires the proponent, TransCanada, to demonstrate the need for the pipeline – in short, to show it will operate near capacity and will not simply remove product that would otherwise be shipped on other lines. This process is designed to avoid what Richard Masson discusses in the Henton article – too many pipelines. Generally, firm shipping agreements are the way in which a pipeline company demonstrates that need.

The Energy East proposal is expected to move north of 800,000 barrels per day of product, so the 100,000 MOU from Alberta will not in-and-of-itself make the project viable. In other words, this is not akin to the Northwest Upgrader processing agreement, in which the province single-handedly enabled the project by signing-on. On the other hand, if the province decided not to become involved in the firm shipping market, they would distort the signals received by the regulators in terms of the demand for shipping services, leaving the system short of capacity and lowering the value of Canadian oil in the process.

Now, what worries me about this? I’m worried about what happens to the oil at the other end of the line. The Alberta government’s responsibility is to maximize the value of the resource, and so they must recognize that in-kind oil has a value, and treat it as they would cash. Don’t give someone discounted oil if you wouldn’t give them money, plain and simple.

We’ve seen a lot of discussion of the potential for Energy East to preserve or create refinery jobs in New Brunswick. This is where Albertans should be concerned. If the purpose of the pipeline, from a shippers perspective, is to get world prices for oil, then why would this have any effect on refinery economics in Saint John? They can already access world prices for oil as they are on a port. If the presumption is that, as part of gaining support for this pipeline, the Alberta government is prepared to market barrels at prices below what they would fetch at market, that’s another kettle of fish.